Brakes On Autos Finance Boom Could Be Placed By Drop In Diesel Car Demand

05/05/2017

A risk to the lucrative financing plans used by major automakers to sell millions of cars is being posed due to a plunge in sales of diesel cars in Europe's two biggest markets is helping to drive down the value of used vehicles.

Authorities across Europe are looking to ban or restrict use of diesel vehicles in some cities and to raise taxes on them that are more polluting after Volkswagen's emissions test cheating scandal.

And according to data this week, with new diesel car registrations in April dropping 19 percent in Germany and 27 percent in Britain that is starting to hit demand hard. That is weighing down on prices of cars in turn.

There seems little prospect of a recovery soon with regulators also looking to encourage a shift to cleaner vehicles.

According to Exane BNP Paribas analysts, last year, fueled by finance packages that now account for nearly 90 percent of sales versus around a half ten years ago, car sales hit a record high in Britain and this outlook is particularly uncertain in that country.

Customers pay a small deposit toward a new car and then make monthly payments for two to three years under the "personal contract plans." After that, they can use the equity to take on a new car, beginning the cycle of monthly payments again after they can either buy the car outright or return it to be sold second hand.

What the finance company believes the vehicle will be worth after the 24 or 36-month period is the deciding factor for how much they can borrow. Customers will have less money to buy a new car - potentially hitting demand for all new vehicles, petrol as well as diesel, if residual values fall more than expected.

"It's a big potential problem if that carries on because it reduces the affordability of vehicles potentially quite significantly," said Exane BNP Paribas analyst Stuart Pearson.

"The question is how fast those residuals go down. In the U.S. we've seen them come down almost 20 percent now, so the UK may have only just begun."

As automakers have slashed prices to try to shore demand up and as demand - which recovered much more quickly than in Europe in the wake of the financial crisis - has stalled, the United States has also seen a sharp fall in residual values in recent years.

Carmakers that have become increasingly reliant on their financing businesses, a similar fall in Europe would hit them. Compared with group underlying operating profit of 14.6 billion euros, the operating profit at Volkswagen Financial Services leapt 10 percent to 2.1 billion euros ($2.3 billion) last year.

With diesel vehicles particularly affected, residual values in Britain have fallen around 3 percent over the past two years. According to some analysts, the trend has been seen in other European countries too.

An assumption of stable residual values is the general basis for pricing of leasing and finance contracts. Demand could be further be dampened, leasing prices could get spiked and cause increase in defaults by a sharp fall in used car prices.

A combined value of 1.6 billion euros could be reached by a 5 percent cut in residual values in Europe, according to Evercore ISI analysts considering the cost for eight major European and U.S. carmakers.